First published: Financial Times, 22/08/2007
The “Minsky moment” in financial markets — the point where credit supply starts to dry up, systemic risk emerges and the central bank is obliged to intervene — has duly arrived. The Federal Reserve’s decision to lower the discount rate last week, while largely a symbolic act, was greeted with much enthusiasm — not least because of a sense of relief that the Fed was prepared to act. This followed a week in which both the Fed and the European Central Bank had injected large amounts of liquidity to help maintain orderly markets. This week the Bank of England also injected liquidity into UK markets as credit supply and funding tightened up.
But while equity markets have stabilised temporarily in anticipation of policy loosening by the Fed, credit markets remain deeply troubled. The immediate focus is on short-term funding, financing flows and counterparty risk. This week, three-month US Treasury bills touched 2.99 per cent, compared with a yield of 5 per cent a month ago. Investors are avoiding securities collateralised against or invested in mortgages. This Minsky moment is not yet over — interest rates in the US and perhaps elsewhere will come down sooner or later. The path ahead is littered with losses, lawsuits and greater regulation. But what about the economic consequences?
Hypothetical scenarios revolve around whether declines in interest rates will spur a new round of risk-taking and de…more
